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What is Fair Market Value?

FAIR MARKET VALUE

Fair Market Value or simply Fair Value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

Moreover, fair market value is also defined as an estimate of the price an entity would realize if it were to sell an asset, or the price it would pay to relieve a liability. Many financial instruments – such as shares traded on an exchange, debt securities (i.e. Treasury bonds), and derivatives – are measured and reported at fair market value.

What are the uses of Fair Market Value?

Fair value is a required measure for many financial instruments. Determining whether a financial instrument should be recorded at fair value in a company’s financial statements depends in part on what type of institution owns the instrument and the intended use of that instrument.

For example, in the case of a broker-dealer, a high percentage of its assets typically is traded and must therefore be accounted for at fair value. Other institutions record financial instruments at fair value depending on what their intent is for holding the instrument or the nature of the business activity. If an institution decided to hold a Treasury bond to maturity, the bond can be shown at its original cost. If the institution purchases another identical Treasury bond that it intends to sell in the near future, that bond would be accounted for at fair value.

In addition to using fair value measures to comply with public reporting requirements, companies measure their financial instruments at fair value for a number of internal processes, including: making investing and trading decisions, managing and measuring risks, determining how much capital to devote to various lines of business, and calculating compensation. The use of fair value measurements is deemed to be relevant in these areas.